Central banks should defuse financial threats: Bernanke

U.S. Federal Reserve Chairman Ben S. Bernanke said financial stability is no longer a “junior partner” to monetary policy and central banks should try to defuse threats in the future.

“The crisis underscored that maintaining financial stability is an equally critical responsibility,” Mr. Bernanke said Thursday in Washington in the last of four lectures to a class of undergraduate students at George Washington University.

“As much as possible, central banks and other regulators should try to anticipate and defuse threats to financial stability and mitigate the effects when a crisis occurs,” Mr. Bernanke said.

Mr. Bernanke’s comments align him with German central bankers such as Otmar Issing, the former chief economist for the European Central Bank, who have long argued that leaning against credit-fuelled financial bubbles was a core responsibility of central banks. Former Fed Chairman Alan Greenspan was skeptical about the Fed’s ability to identify bubbles or choose correct values for asset markets and emphasized a policy of cure, or mopping up bubbles with aggressive policy after they popped.

Mr. Bernanke is using the lectures as part of a broader effort by the Fed to explain its policies and role to the public as lawmakers and political candidates scrutinize its actions. The chairman has also started holding press conferences after meetings of the Federal Open Market Committee.

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In other comments, Mr. Bernanke said the pace of recovery from the recession has been “extremely sluggish,” while action by the world’s central banks helped prevent another Great Depression. In the aftermath of the crisis, the U.S. has bolstered financial oversight, and the banking system is now “significantly stronger.”

The Fed has taken unprecedented steps to revive the world’s largest economy and prevent another economic contraction after the 18-month recession that ended in June 2009.

The central bank in December 2008 lowered its target overnight interest rate to a record range of zero to 0.25%, and it later purchased US$2.3-trillion of assets in two rounds of so-called quantitative easing.

At its September meeting, the FOMC announced a move, dubbed Operation Twist, to replace US$400-billion of short-term debt in its portfolio with longer-term Treasuries in an effort to reduce borrowing costs further and support the economic rebound.

Emergency Dollar Funding

In November, the Fed and five other central banks announced plans to cut the cost of emergency dollar funding for European lenders as part of a globally coordinated response to the region’s sovereign-debt crisis. The Fed said that the premium banks pay to borrow dollars overnight from central banks will decline by half a percentage point to 50 basis points. The move was coordinated with the European Central Bank and the central banks of Canada, Switzerland, Japan and the U.K.

Policy makers said at their last meeting on March 13 that they will continue the operation to lengthen the average maturity of holdings. The Fed also said it would maintain its policy of reinvesting maturing housing debt into agency mortgage-backed securities.

Mr. Bernanke used his March 27 lecture to focus on the Fed’s response to the financial crisis, asserting that policy makers helped prevent it from becoming a worldwide catastrophe. In previous lectures, Mr. Bernanke examined the roots of the crisis, including the boom and bust in home prices and the Fed’s failure to recognize vulnerabilities in the financial system.

Thursday’s lecture focused on the Fed’s response, the regulatory response, and the long-term implications of both. The students gave Mr. Bernanke a gift Thursday: a framed front page from The New York Times’ April 20, 1933 edition which featured a four-column headline announcing: “Gold Standard Dropped Temporarily To Aid Prices and Our World Position; Bill Ready for Controlled Inflation.” Mr. Bernanke is a Great Depression scholar.